My Big Property Prediction for 2014…

In my last post I outlined the reasons why I thought 2014 was going to be a big year, and house prices were on track for some impressive growth.

Now every time I say something like this, people look at me sceptically. Houses are already so expensive. How can they go higher??

How can they go higher, unless there’s a bubble??

First of all, there’s a lot of people who claim Aussie property has gone bubble. But just because something’s expensive doesn’t mean there’s a bubble. BMWs are expensive, but that doesn’t mean there’s a bubble in BMWs.

And if you look around at what’s going on overseas, it doesn’t look like there’s a bubble here – even in super-charged Sydney.

Take a look at this chart here, from ANZ. This looks at house prices in a number of major cities around the world.

What it shows is that price increases in Sydney have been relatively tame. We’re certainly no Shanghai! We’re not even a London or Toronto.

So if someone tells you that Sydney property (let alone the other capitals) is in a bubble and it’s about to burst, tell them you might believe them once the bubbles in Shanghai, Hong Kong, Toronto, Singapore and London have burst first. Until then, it’s not something to worry about.

But price is a really simplistic guide to spotting a bubble. And not that helpful. As I said, just because something is expensive, doesn’t mean there’s a bubble. We’ve got to dig down past simple price movements, and look at what’s going on at the most fundamental levels – supply and demand.

So the first question we need to ask ourselves is, is there enough demand to support prices at the current level?

Another way to get at this is to ask the question, can people afford the houses that are on the market now.

This is getting at the idea of ‘affordability’ and it’s fundamentally important.

There’s a few ways I’ve seen to cut this up, but none of them are telling us that house prices are out of reach and that there might be a bubble.

The first one I like comes from RP Data and HSBC. It looks at average house prices as a multiple of household incomes over the past 20 or so years.

What HSBC argue is that around the turn of the millennium there was a level shift in the house price multiple. Through the 90s is held around a consistent 2½ times income.

But after the turn of the millennium it took a step up. They argue that there were some fundamental changes to the market that caused that to happen. Interest rates fell and were held low, inflation expectations became contained, and there was easier access to credit.

This meant that people could afford to spend more on their houses, and they did. The multiple jumped up to 4.2 times. But people weren’t worse off. Because interest rates had fallen and incomes were rising, it effectively cost them about the same.

So the millennial jump had everything to do with a structural change in the market, and nothing to do with a bubble. That’s why it’s held steady at 4.2x since it made the jump.

ANZ also have a chart looking at affordability I find very evocative.

They calculate their own measure of household purchasing power. Basically they’re adjusting household income to account for prevailing interest rates. Then they compare that purchasing power to actual house prices:

What they show is that, right now, following five years of go-nowhere growth in house prices, and at the same time as incomes have been rising, actual purchasing power is now running far ahead of actual prices!

The implication is that prices are actually cheap right now. And since the 80s purchasing power and house prices have always come back into alignment, but it’s always prices that did the adjusting. Purchasing power tends to grow steadily.

To make it clear what that means, I’ve highlighted it here on this chart:

The last time we had a gap like this was back in 1998. The gap then was around $80,000. What we saw was that, over the next four years or so, prices made that gap up very quickly, and then some, until they finally caught up with purchasing power.

By the time they did, prices had risen over 50% in four years!

That’s the kind of gap we’re looking at now. There’s almost $100,000K difference at the moment. That gives you a feel for the kind of catch up we can expect… at a minimum.

But if incomes keep growing – and as I said in my last post, there’s every reason to think that they will – then the reunion point could be at a much higher price. Just eyeballing it, it looks like it could be around the $700,000 mark.

From current levels, that means about a 30% increase in just a few years!

So much for that bubble.

But is that really what we can expect? Sure demand is bumping along with rising incomes and foreign interest. But what’s happening to supply?

Well, as I’ve argued before, Australia is actually pretty crap at building houses. We’re just not building enough of them.

This chart here tells the story:

New home sales have been falling for the better part of a decade… and in a big way too. New home sales are down from around 160,000 a year at the beginning of the millennium, to about 80,000 now.

That’s a 50% decline!

So supply is lagging way, way behind. And so if demand is forging ahead, but supply is lagging behind, that’s got to be driving us towards a shortage.

And that’s exactly what we’re seeing.

This measure from CBA looks at the demand and supply balance. On their measure, we swung from surplus to shortage around the time of the GFC, and we’ve had a serious shortage since.

And shortages mean rising prices. But we haven’t seen that have we? No. Confidence has kept a tight lid on things.

But that just means we’ve got a lot of catching up to do! Prices are a tightly sprung coil.

So the take home message is this. No, there is no bubble. Aussie house prices don’t appear over inflated. In fact, looking at purchasing power, we should expect to see some big price increases in the years ahead. And looking at the supply / demand balance, huge shortages also imply that big price increases are on the cards.

Prices are being jacked up by both demand and supply. To my mind, 30% over the next couple of years would have to be the minimum.

Comments

You are leaving out a key factor in this analysis, we appear to be heading for an economic rough patch with a reduction in mining incomes and a restriction of government project spending purse strings federally, These two sources both have a large flow on effect through the economy which ultimately end at the wage packet, the expectation of rising incomes is perhaps hopeful but not supported by the reality in the field. The perception of job uncertainty also flows on to people being less committed to big loans and this is probably one of the factors influencing a decline in new home starts. Its not all about the graphs, all the inputs to both supply and demand have to be considered (which you did with interest rates and inflation but not with incomes)

There is not going to be any major reduction in Mining Incomes. There is a reduction in Mining Investment at the moment – because there has been a high level of Investment in increasing our
Mining production. There was a reduction in Mining income of less than 10% over the last year – due to temporary drop in Prices – which have recovered now. Now that this increased and still increasing Production comes on at those recovered Rates – Australia’s Mining Income is set to make a healthy increase.

Although commodity prices may improve, and China demand possibly remain strong, the offset in the falling Australian dollar mitigates this. I think too the reliance on mining needs to be carefully examined given that some greenfield sites are already being mothballed due to the scarcity of capital for startup sites at the moment. Im not sure what you are basing your optimism on but am truly genuine in seeing any data you may have to support it..

Iron Ore is our biggest mining export. Exports from WA increased by almost 13% from 2012 to 2013 – but with Rates under $100 / T – income from Iron Ore actually dropped. The major players are now working to wards further production increases of up to 30%. With Rates now back up around $140 – Income from Iron Ore is set to increase significantly.

As usual, that Headline says big bad things. The article then goes on and “is pleasantly surprised” with the take up of those jobs in the Oil and Gas area. Give scant regard to such sensationalised headlines – or Government predictions. Construction is construction. This industry will build whatever where ever – as per normal. To make a big issue of the fact that these workers are moving from constructing for the Iron Ore Mines to construction for Oil and Gas is misleading. The fact is that the this frantic construction industry has and is increasing Iron Ore production significantly – and that will similarly increase our Income from Iron Ore. That Construction workforce is now moving over to construct for Oil and Gas (Barrow island, Wheatstone and more) – which will also give significant increases from those exports when completed. In WA alone there has been over $200 Billion spent on increasing exports. That money being spent now will significantly increase Export income in the coming years. WA export income from Mining, Oil and Gas 2013 was $100 Billion. The ongoing frantic pace of construction in these areas will increase this figure significantly.

Well said, Jon. The more I look at your info, the more confident I feel about my own beliefs. Residential real estate will double in price every 7 to 10 years eventually in the long term, and one must be patient so as not to miss the boat. Cheers, Ken.

Hi Elaine, Age has little to do with what you do from now on. If you haven’t been listening to Jon’s or Dymphna’s blogs, just remember, if you want an investment property, the main thing to know is, you make your money when you buy a property, not when you sell it. This means buy right and you virtually can’t go wrong. I see so many people doing renovations on a property they bought for $500,000. To me, this is nothing short of stupidity. Just please don’t fall into this trap. If necessary, buy in another town. Sydney, for example, is the main place to stay away from. Cheers, Ken.

Talking about the future of a market, estimating, it is always open to all the factors affecting it.
Missing to consider factors such as a possibility that mining incomes will be reduced, or the new Infrastructe PM will be reducing government spending for projects, or floods and more fires, and why not more asylum seekers, etc etc; it may let some people with doubts on the truth of all these. The reality is that this report is only a discussion, based on historical data, that can be valued by individuals as Gold or as …..
Personally I believe on simplistic theories. Supply and Demand is as simple as you can get. The other simple theory is the cycle of the market. Your tops and bottoms. There are some elements on this report supporting and uplift on the property market due to an increasing Demand and a Cycle of the property and I welcome them as supporting information for me.
All the other factors in or out on this report, are up to the individuals to react on them and take your own investment decision.
Thank you for the report, I found it interesting.

Hi Jon. This personal to you alone. I won’t comment anymore on your blog, your views, your anything. I will not attend any of your promotions in the future either. I can find other events to attend if necessary. Why? I take the time to share in the comments and replies with the rest of these people, but never can I see my view on your blog reply area. If my view or comment is not good enough to be shown, then I will not comment or reply again.
Thanks for your previous efforts. Bye now.

Hi Leo, I was nothing short of shocked when I read your comment. I always see mine immediately. All I can say is, if you’re not stirring, you must be doing something wrong. Well, just think about it, you got on this time, didn’t you? Cheers, Ken.

The first chart shows increase in house prices in the major cities shown below the chart. The values on the Y axis (vertical axis) represent percentage of the starting point. That is, the point of origin (100%) is the house price in 1998. For example, London house prices in 2003 are twice what they were in 1998 (200%).
-Brendan

Hi All, I work in the mining, Oil & gas WA, I can tell you there is 5 years work in building the plants and camps, we just signed the contracts, I was working in iron ore, 3 years which had slowed down.
I’ am thinking what if house prices go pair shaped, Its good to read the blogs and see the graphs
and gives me more confidence

Kirston has said it all. 5 years of building Plants and Camps – that will increase Export Incomes well into the future.

And Kirston – if the big Banks thought that there was even half a chance that our Housing prices might go pear shaped – then they would not be competing against each other to finance 80% of the Housing that we are buying.

I concede the point regarding the Iron Ore sector and its effect on exports, however that alone isnt enough in my opinion, Probably the next best future development area is the large reserves of LNG in SA, NT and WA as well as offshore. Unfortunately the resource industries only employ within a relatively narrow range of skills and represent a minority of employees so my comment stands. The economy will remain uneven and this will make property price growth spotty. Despite my general opposition to the MRT the idea of ensuring a social dividend from prosperous areas of the economy (and Im thinking widely here, banking, mining, tech, property investment etc) generally does offset the tax shortfall likely to occur with Australia’s growing and aging population who, like it or not are going to have to lean on government handouts going forward at some point as they retire (Not all of them of course) Some states like Tasmania are a long term representation of this with limited or no growth for more than a decade on inflation adjusted terms. So those areas with out some sort of development boost and driver for employment are unlikely to do much at all, They are domitory regions. Without a general spreading of wealth and expansion throughout a much wider number of participating economic sectors (income producers) I see no reason at all for this to change. Certainly spikes and booms driven by optimism will occur as the rush to the latest, greatest thing occurs (Northern Development Zone anyone?) but so too will the sell off when the relaity kicks in. Long term? More of the same I would say.

What we are talking about is Property Investments in 2014. This could be seen as ‘Analysis Paralysis’. Your ‘What If’s’ are still to big. Settle one – find another. This will get nowhere fast – as opportunities go by.
Look at the big picture. The Australian economy is the envy of the world – and is growing. The Population is growing and that increase needs somewhere to live. The greatest population increase will see the greatest increase in Property Values. Perth, Brisbane and Darwin will have the greatest Population Increases. I am working towards having a Debt of $6M against $10M worth of Properties in Perth, Brisbane and Darwin. The $10M will service the $6M Debt – and I will live off Capital Gains. 10% Growth on $10M is $1M. Take a deep breath and jump in.

Darwin is looking toppy with a net withdrawal in labor predicted, also not much to follow once Impex is settled in 3 years, there is a new iorn ore deposit out the gulf way but although that helps government coffers it doesnt feed any demand for housing, agree with Perth and parts of Queensland though

The ABS predict that Darwin will be the third best increase in Population. With the US and Oz military moving into Darwin big time – that’ll do me. I am looking at a DHA Property in Darwin.
Elaine from 17/12 – I started at 57 – without contributing one dollar from my income. Just by using the Equity in our Home I have bought Brisbane then sub divided and are developing one in Perth. Made a good quid doing that – maybe do another before DHA Darwin, Or maybe that as well at the same time. The most important thing is that I am getting Growth on 4 properties rather than one.
And Ken – I don’t have to make my money when I sell – or buy. My strategy is buy and hold.

Hi Murray Mac, Mate, I am well aware of the buy and hold thing. This is ok if you don’t need an income or have a large amount of equity in real estate. I was thinking that maybe Elaine may not have had. I am into Renovations and will make more money buying right and selling, than holding, after renovating. However, it is my intention to do both selling and holding for the short term and the long term. Cheers, Ken.

Yes Ken. Not keen to buy and sell – too many fees and Capital Gains Tax could come in to it as well. Real keen to buy, sub divide and build to go positively geared – without spending any income at all. Equity can cover all costs. Growth is where we can make money – and manufacturing that growth either way will certainly assist. Short term with property is riskier and therefore not even an option.

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